Market investors waiting for next bubble to burst

By CHET CURRIER, BLOOMBERG NEWS

Published 10:00 pm, Friday, July 11, 2003

A stock market recovery has just begun, and investors are already worrying about the next calamity.

Such is life in stocks and stock mutual funds. It took almost three years to bring the market down from the speculative "bubble" of the late 1990s. Now, less than a year off the bottom, we hear all sorts of foreboding talk.

"Bubble II" is now in the making, warns Ben Stein, co-author of the book "Yes, You Can Time the Market," in a letter to The Wall Street Journal.

"It is still a good time to keep one's head down," says Jeremy Grantham, chairman of Grantham, Mayo, Van Otterloo & Co., a Boston money manager with a fast-growing $14.6 billion mutual-fund group.

"Before the peak of the bubble," Grantham writes in a shareholder letter, "I argued that the bear market would last a long time and would contain at least one economic recovery and probably two before the market hits its eventual low, which I still believe. An economic recovery does not magically justify an overpriced market."

What's an investor to do -- shrug off such warnings as pointless pessimism, or heed them and flee the stock market? Neither of those extremes has much appeal.

Managing money demands that we keep investing in some way or other, with appropriate safeguards such as diversification. While we go about this task, we are obliged to pay due attention, and respect, to the perils surrounding us.

By most historical measures stocks today can't be bought cheap. At this writing the price-earnings ratio of the Standard & Poor's 500 index is 32.5 times the most recent 12 months' earnings of its component companies. Those stocks' aggregate dividend yield is a meager 1.6 percent.

That payout looks a little less skimpy when put it up against yields in the bond market, where the two-year Treasury note has lately been yielding about 1.3 percent and the 10-year note 3.7 percent. Dividends can grow, while bond interest payments are fixed.

Even so, this relativist argument starts looking questionable should interest rates rise, as we would expect them to do in any sustained economic recovery.

There is ample precedent for a "double dip" bear market. Investors of a certain age don't need to look it up in a history book -- they can remember all too well how it last happened, from the late 1960s through the mid-1970s.

In the 1968-70 drop, according to my Bloomberg, the Dow Jones industrial average hit a low daily close of 631 in May 1970. A subsequent recovery took it as high as 1,052 in January 1973. Then it tumbled again to 578 in December 1974. That's right, 4 1/2 years after the 1970 market bottom the Dow hit a low that was 8.4 percent below the first. Were that pattern to repeat this time, we would see a Dow of 6,674 some time around May 2007.

Even if history never repeats exactly, the grisly details from 30 years ago bear a compelling message. Could such a thing happen again? It certainly could. What's more, we have been shown that it can happen in the midst of the most prosperous age the world has ever seen.

The mind recoils at the thought of exposing all one's hopes to such extravagant risk. And yet, what other choice do we have -- put all of our 401(k) money in bonds or money markets with interest rates near 40-year lows? Waiting until every wise head agrees it is safe to own stocks won't work.

Now Playing:

The S&P 500 has gained 11.4 percent a year, on average, over the last 50, and 10 percent a year over the past 10, through mid-2003. At no time during either stretch was it "safe" to buy stocks. Investors who insist on an S&P 500 P-E multiple of, say, 12 or less haven't put a penny in since 1989.

Stocks offer the hope of generous rewards precisely because they are risky. In taking on the challenge of balancing those risks and rewards somehow, recognizing both clearly is a good place to start.